Understanding the Mortgage Interest Tax Deduction

The mortgage interest deduction has been a hot-button issue in the headlines lately. The California Association of Realtors conducted a survey of home buyers and found that 79% said the mortgage interest deduction was "extremely important" in their decision to buy a home. Yet, conversely, per the IRS, only a quarter of the tax filers claim the deduction.

The first "modern" income tax was created in 1894, but was quickly ruled unconstitutional. In 1913 the constitution was amended and the new tax law was created where all interest was deducible; however, it was not meant initially to help the middle class. At that time the taxes excluded the first $3000 of income, not especially helpful as less than 1% of the population actually earned more than that per year and most people paid cash for their homes. Reasons for the deduction were that we were a nation of small proprietors and it was difficult to separate personal from business expenses, so it was simply easier to all concerned to allow deductions of interest. Post WWll this deduction was hyped up as a way to make home ownership more affordable to the middle class and it worked very well. After all these years we've become use to having this available and homeowners count on this deduction when thinking about how much of a home they can afford. The Tax Reform Act of 1986 eliminated most of the interest tax deductions, but kept the mortgage interest deduction, this time, hoping to encourage home ownership.

Having a tax deduction for mortgage interest does make owning a home more affordable as it lowers the amount of taxes a homeowner pays. So why do only a quarter of home buyers claim the deduction? Current tax laws allow homeowners to deduct the interest on debts secured by a principal residence only up to the first 1 million of debt owed. That 1 million of debt owed includes funds used to acquire, construct or substantially improve the residence. The deduction seems to have a greater benefit for those wealthier homeowners who have the larger mortgage balances and, most importantly, the wealthier homeowners itemize deductions on their taxes...one of the "musts" to claim the deduction. Clearly, the total itemized deductions must exceed the standard deduction to reduce the homeowner's taxes, again, a greater benefit to the wealthier homeowners.

So do we as tax payers still need the deductions? Is depends on who you talk to. The National Association of Realtors is strongly in support of the deduction; believing it is "vital to the stability of the American housing market and economy". Some believe that without the deduction, home prices would fall at an estimated 3-15% and lower housing prices mean less property taxes to the states. They also point out that lower home prices would create hardships for current homeowners already "upside down". Others say the deduction saves homeowners almost 80 billion per year.

On the flip side, some argue that the tax break actually does very little to boost homeownership, particularly for the middle class, as people wealthy enough to benefit are still likely to buy homes regardless, pointing out how popular this deduction is in the high cost areas of California, Hawaii, Washington, Virginia and Maryland. Moreover, the IRS says the deductions cost the tax payers almost 100 billion in lost revenue.

Based on the IRS statistics, showing only that 25% of homeowners benefit from the mortgage interest deduction, and the National Association of Realtors support of the mortgage interest deduction, the actual merits of the mortgage interest deduction depends on your individual situation. For those who itemize their deductions, the mortgage interest deduction is beneficial. For those who do not itemize their deductions, they still benefit from building equity in their home in the long term.

Julie Vaissade-Elcock is the Broker/Owner of Vaissade Mortgage Company located in Arcata.